House Bill 465, also known as Act 52, was signed into law by Pennsylvania Governor Tom Corbett on July 9, 2013. The Bill makes substantial changes to the Pennsylvania tax code as an integral part of the 2013–2014 budget. While legislation impacting your federal tax bill has become commonplace, changes at the state and local levels are less frequent but no less significant. This Alert highlights select changes enacted by this legislation.
Personal Income Tax
- Taxpayers may deduct $5,000 of business startup expenses for tax years beginning after December 31, 2013. This change is consistent with the federal deduction already allowed.
- A tax credit for taxes paid to foreign countries is no longer allowed for tax years beginning after December 31, 2013. The credit allowed for taxes paid to other U.S. states will remain in effect.
- Provides for the option to capitalize and recover certain allowable intangible drilling costs. Taxpayers may elect to currently expense up to one-third, with the remainder recovered over 10 years, effective for tax years beginning after December 31, 2013. No deduction is permitted for intangible drilling or interest costs in connection with transactions with affiliated entities.
Family Business Exemption to Inheritance Tax
Effective for the estates of decedents passing on or after July 1, 2013, the Pennsylvania inheritance tax will not apply to the transfer of a "qualified family business interest" to one or more "qualified transferees," thereby making it easier for businesses to be favorably passed down from generation to generation. To qualify for this exemption:
- The family business must have been in existence for five years, have fewer than 50 full-time equivalent employees, have a net book value of less than $5 million, be owned as a sole proprietorship by the decedent or be an entity wholly-owned by the decedent or by the decedent and qualified transferees.
- A "qualified transferee" is the decedent's spouse, lineal descendent, sibling (and the sibling's lineal descendants) and ancestors (and the ancestor's siblings). The exemption is lost if the business does not continue to be owned by a "qualified transferee" for seven years after the death of the decedent.
- An entity with the principal purpose of managing investments or income-producing assets owned by the entity will not qualify.
- Requires annual certification to the Department of Revenue that the family-owned business interest qualifies for the exemption, as well as notification to the Department of Revenue within 30 days of any failure to qualify.
- Effective for all tax years beginning after December 31, 2013, classification of partnership and corporate (S corporation) items of income or credits will be determined at the partnership or corporate level.
- Beginning in 2014, estates and trusts will be required to withhold Pennsylvania tax on Pennsylvania-source income from non-resident beneficiaries, and nonresident estates and trusts will be required to file a Pennsylvania return if they have Pennsylvania-source income. Under existing law, partnerships and S corporations with Pennsylvania-source income are required to withhold only personal income tax from nonresident partners or shareholders. Under the new law, that withholding requirement is now extended to estates and trusts with nonresident beneficiaries.
Several new credits have been established, while others have been modified, including:
- Innovate in Pennsylvania Tax Credit – Effective October 1, 2013, this credit provides a new source of funding for early stage venture capital investment for biotechnology-based projects The commonwealth's economic development partners—Ben Franklin Technology Partners (50 percent), PA Venture Capital Investment Program (45 percent) and other regional biotechnology research centers (5 percent)—will administer the funding for early stage tech investments in Pennsylvania. Credits may first be used in 2017 for taxable years that begin in 2016.
- Film Tax Credit – Effective July 1, 2013, this credit now requires production companies to withhold Pennsylvania personal income tax (PIT) from the portion of Pennsylvania income paid to individuals through pass-through entities. The Director of the Pennsylvania Film Office is also granted authority to consider other criteria when evaluating and approving credit applications to ensure the maximum employment benefit is realized in Pennsylvania. Tax credits purchased or assigned in 2013 and 2014 can be carried forward to 2014 and 2015, respectively.
- City Revitalization and Improvement Zones (CRIZ) – Establishes a program for economic development and job creation in third-class cities (at least 30,000 residents), meeting certain criteria where state and local taxes generated in the zones could be used to finance the construction and development of commercial, sports, exhibition, hospitality, conference, office, retail or other community recreational or mixed-use purposes. In addition, the law establishes the approval process for two additional zones beginning in 2016 and approval of one "pilot" zone within a township or borough with a population of at least 7,000. The law relating to the implementation of the CRIZ legislation plan is anticipated to be published by October 31, 2013.
Capital Stock and Franchise Tax
- The capital stock and franchise tax (CSFT), which was to be phased out for tax years beginning after December 31, 2013, has been extended for an additional two years, with phase-out delayed until 2016. The rates remain low and will decline from the current 0.89 mills in 2013 to 0.67 mills in 2014 and 0.45 mills in 2015. It is eliminated in 2016, effectively ending Pennsylvania's role as the only state in the nation to tax both business income and business assets.
Sales and Use Tax
- Removes the sunset provision that was due to expire on June 30, 2014, and permanently extends the additional 1 percent Philadelphia sales tax.
- Establishes a retail sales tax exemption for sales of aircraft parts, services to aircraft and aircraft components (includes fixed-wing powered, tilt-rotor, tilt-wing, glider and unmanned craft).
Corporate Net Income Tax
- Effective for tax years beginning after December 31, 2013, the commonwealth will adopt market-based sourcing for the determination of receipts allocable to Pennsylvania. The receipt from the sale of a service will be sourced to Pennsylvania for apportionment purposes if the service is delivered to a location in the state, or is based on the relative value of the services delivered to Pennsylvania, and will not be sourced based on where the income-producing activity occurs, as is the measure currently.
- Effective for tax years beginning after December 31, 2013, special apportionment rules for satellite television providers will be based on the value of equipment owned or rented in Pennsylvania and used in generating, processing and transmitting satellite television services. The apportionment to Pennsylvania will be the Pennsylvania value of the equipment owned or rented by the taxpayer (or entity included in the taxpayer's controlled group) over the value of all such equipment owned and rented everywhere. These apportionment rules apply whether or not such equipment is affixed to real estate.
- For tax years beginning after December 31, 2014, the new law requires the add-back to income of intangible expenses (including interest expenses directly related to intangible expenses) on transactions with affiliated entities. There are a few significant exceptions, including an exception for arm's-length transactions that do not have the avoidance of tax as the principal purpose, effectively closing the Delaware Loophole, which is a tax avoidance practice utilizing the transfer of assets to Delaware holding companies resulting in tax at lower rates.
- Increases the Net Operating Loss (NOL) cap from $3 million or 20 percent of a company's tax liability to $4 million or 25 percent of a company's tax liability in 2014 and $5 million or 30 percent in 2015.
- In order to encourage greater compliance with the tax law, this law establishes a new penalty of $500, plus 1 percent for every dollar of tax greater than $25,000 as a non-filing penalty for C corporations.
Realty Transfer Tax
- Beginning in 2014, the law clarifies the definition of "real estate company" to include a corporation or association that owns a direct or indirect interest (a tiered structure) in a real estate company, comprising 90 percent or more of the fair market value of its assets. The law also changes the criteria for determining when 90 percent or more of the total ownership interest in a real estate company has been deemed to be transferred, and thus triggering the transfer tax.
- Establishes a new exemption for certain real estate transfers to volunteer emergency services agencies, volunteer fire companies or volunteer rescue services. This new exemption is retroactive to transfers that occurred on or after November 1, 2011.
Tax Appeals Reform
- Effective April 1, 2014, the bill reorganizes and reduces the existing Board of Finance and Revenue from six to three members, consisting of the State Treasurer (or designee) and two members nominated by the Governor and approved by State Senate who must either be attorneys or CPAs with substantial knowledge of Pennsylvania tax law.
- The Department of Revenue will be entitled to present oral and documentary evidence before the Board by the taxpayer (petitioner) and the Department of Revenue.
- Additionally, the Board may order a compromise settlement with agreement of both parties.
- Citation Authority – Effective immediately, a person who does not pay or who underpays employer withholding tax or fails to file an employer withholding return or report may be fined by the Department of Revenue; and in some instances, the violators may be imprisoned.